The Financial Post recently reported that Canadian real estate investment trusts (REITs) have rallied to the highest levels in five years, and that’s despite Finance Minster Jim Flaherty’s constant threat of increased interest rates.
So, just what is a real estate investment trust and how can it impact your best mortgage rate search? Let’s take a look.
What is a REIT?
To put it simply, real estate investment trusts are funds that pool investors’ capital and deploy it in the purchase of an income-producing real estate purchase. Real estate has always been a mainstay of income-seeking investors for decades; real estate incomes trusts are an extension of this method and an excellent option for investment diversification.
There are many benefits to investing in REITs. First and foremost, unit holders benefit from a diversification in assets that would be impossible to achieve were they investing individually. On average, REIT investors generally yield between 7-9% per annum based on the rent collected, less management fees. Real estate investment trusts are also relatively tax efficient. REITs are depreciated in such a way that much of the returns to investors are designated as “return of capital,” which defers most of the income tax while at the same time effectively lowering the investors’ cost base.
Canadian real estate investment trusts can be purchased like any other public company/stock through the stock market.
Big Gains = Big Business
Investors in REITs have enjoyed immense gains as the 10-year Canadian bond yield fell by more than half, effectively boosting the value of their holdings. The national office vacancy rate has also fallen to 8.2% in the first quarter from 9.3% in 2011 according the CBRE Group. Apartment vacancy has also been on the decline.
The increase in occupancy and rents has helped to bolster the REIT market exponentially. According to Michael Missaghie, a portfolio manager at Sentry Investments, “The REIT sector is one of the only places you’ll be able to get a sustainable yield in the Canadian investment landscape.”
Consumer Debt and REITs
While the Bank of Canada has managed to keep its benchmark interest rate at 1%, consumer debt burden is among the country’s biggest financial risks. And, even though the threat of increased interest rates are apparent, valuations on REITs are expected to stay where they are, if not creep even higher.
The government’s efforts to curb consumer debt may work in favour of REITs, especially those that deal with rental apartments. According to most sources, Ottawa’s policies are geared towards tightening underwriting standards, which will ultimately make it more difficult for first time home buyers to secure a best rate mortgage. When push comes to shove, the inability to secure financing will force buyers to stay in the rental market longer.
If you’re a first time home buyer in search of a best rate mortgage, keep your eye on REITs. While you may not have the capital to invest in a fund, these investment products are a great gauge of the mortgage market. Money flows out of REITs when interest rates start moving higher. During the recession, the Canadian REIT index dropped by 2.2% from its peak after a 10-year Canadian bond yield surge. Depending on government policy, the current rate of 2.04% posted April 23 could mark the beginning of a turning point in the REIT market.